A Sinking Feeling Over The Dollar

[Chart: The U.S. dollar index tracks the dollar against a basket of six other currencies.]
In a Slump
By Neil Irwin
Washington Post Staff Writer
Thursday, November 8, 2007

The value of the dollar fell sharply yesterday, as did the stock market, after the Chinese government signaled that it might slow its purchases of U.S. assets.

The Dow Jones industrial average plummeted nearly 361 points, or 2.6 percent, as the dollar fell to an all-time low relative to the euro and was sharply lower against other currencies. The fall in stocks reflected worries that the dollar would continue to slide, which would make the dollar-based earnings of U.S. companies less valuable relative to foreign investments.

Other factors in the market's swoon were weak earnings from General Motors and potential troubles for mortgage finance companies Fannie Mae and Freddie Mac.

"The Dow Jones is measured in dollars, not bananas," said Peter Schiff, president of Euro Pacific Capital. "As the dollar loses value, U.S. stocks lose value."

Top Chinese officials suggested at a conference yesterday that they would direct more of their future reserves into European assets -- that the euro, not just the dollar, would increasingly be a currency of choice. For years, China has kept its currency artificially low relative to the dollar by buying hundreds of billions of dollars worth of U.S. assets, especially Treasury bonds. This has made Chinese imports inexpensive in the United States and made it cheap for Americans to borrow money.

"We will favor stronger currencies over weaker ones and will readjust accordingly," said Cheng Siwei, vice chairman of China's National People's Congress. Another official said the dollar was losing its position as the world's default currency.

The words were consistent with signals the Chinese have been sending about wanting to move away from pouring all their reserves into dollars. It wants to make such a move slowly and gradually, however. A sharp appreciation in the Chinese currency, the yuan, would put its exporters at a competitive disadvantage in the United States and could cause higher unemployment and slower growth.

"There is no doubt that in the medium to long run, they will be diversifying their currency assets," said Domenico Lombardi, president of the Oxford Institute for Economic Policy. "But it is likely that people are overreacting to the latest comments. We ought to wait a little bit before we make a firm judgment on what it means."

Since mid-August, the price of a euro has risen to $1.46 from $1.34, an unusually large increase. Part of the drop in the dollar has come about because the Federal Reserve, by cutting interest rates twice in the past two months, has lowered the returns that one can earn by saving dollars.

A cheaper dollar was not unexpected when the central bank cut interest rates. In fact, it is one of the ways that lower interest rates stimulate the economy. A cheaper dollar makes U.S. exporters more competitive on global markets. Economists are expecting a stronger export sector to help ease the pain from the sharp decline in the housing industry.

But a weak dollar could also spur inflation. Part of the reason that prices for oil and other raw materials have risen sharply in the past month is that the dollar is worth less. And prices could eventually rise even for finished goods that Americans import from abroad, items as varied as luxury automobiles from Germany and textiles from Indonesia.

"Already core consumer import prices are rising at the fastest pace in a decade," said Dean Maki, chief U.S. economist of Barclay's Capital. "And the ongoing decline in the dollar suggests that the pace of the increase could accelerate going forward."

There were more culprits in yesterday's slumping stock market than the decline in the dollar. General Motors said after the market closed Tuesday that it would write down $39 billion in assets because it is not confident that it would make enough money in the future to reap tax benefits from past losses. GM stock was down 6.1 percent for the day, closing at $33.97 per share.

Shares of mortgage companies Fannie Mae and Freddie Mac also fell yesterday after New York Attorney General Andrew Cuomo subpoenaed the federally chartered mortgage-funding companies in an investigation of mortgage fraud. Shares of mortgage issuer Washington Mutual fell, too.

And after the market closed, Morgan Stanley said it would write down the value of its assets by $3.7 billion, reflecting continued turmoil in the markets for mortgage and other debt. Wall Street's biggest names have announced repeated multibillion-dollar write-downs in recent weeks, reflecting continued problems valuing complicated debt securities.

The Dow fell 360.92 to 13,300.02. The broader Standard & Poor's 500-stock index fell 2.9 percent, or 44.65, to 1475.62. The Nasdaq composite index fell 2.7 percent, or 76.42, to 2748.76.

© 2007 The Washington Post Company